COMPLIANCE
OVERDRIVE
Flat Fees vs. Discretionary Compensation for Dealers
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T H E D E B A T E C O N T I N U E S
In March 2013, the Consumer Financial Protection Bureau published guidance on compliance with fair lending requirements for indirect auto lending. Since then the issue has grown to become the industry’s most significant compliance issue in quite some time. In December, the CFPB entered into a consent order with a large lender involving millions of dollars in damages and penalties. Others could follow. Be prepared, because this issue may also result in lenders changing how they pay dealers for retail contracts. The CFPB’s focus is on how lenders compensate dealers when they buy completed retail contracts. After analyzing information about a proposed credit sale, an indirect auto lender will offer to buy the completed retail contract if it has a specified (minimum) contract interest rate. Sometimes the minimum rate is referred to as the “wholesale rate” or the “buy rate.” Some lenders pay dealers a share of the increased interest revenues if the completed contract interest rate is more than the buy rate. This practice is often referred to as “dealer rate markup,” “dealer reserve” or “dealer participation.” The CFPB’s concern is that dealer discretion to increase interest rates may result in some buyers paying more than others – which is a INDEPENDENT
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DEALER
violation of the law if the pricing disparities affect buyers of one race, gender or other protected group more than others. To be clear, there is no debate about the evils of intentional credit discrimination. Every reputable auto dealer and lender condemns discrimination against buyers on the basis of race, ethnicity, gender and all other classes protected by the law. Intentional credit discrimination is against the law, is bad policy and has no place in this industry. Everyone agrees. The current issue is more subtle because it involves unintentional discrimination, referred to as “disparate impact.” A dealer and lender could implement what they believe to be discrimination-free business policies and practices only to find that they result in statistical anomalies showing buyers of a certain race or gender are paying more for credit. Unless the variations can be justified by legitimate business needs, they are violations of law because they have a discriminatory impact on certain protected buyers. It doesn’t require the dealer or lender to have discriminatory intent. It only matters that their actions had a disparate impact. The CFPB’s guidance last March and its actions since then have all focused on dealer discretion to increase lender’s MARCH/APRIL 2014
buy rate and the risk that such discretion may lead to a disparate impact on protected buyers. If a dealer doesn’t have a set of rules for how and when it marks up the buy rate, then how can it ensure that buyers with similar credit profiles are being treated equally? For example, if a dealer’s only credit pricing rule is to charge each customer as much as he/she will bear, then it is not trying to provide the same credit pricing to buyers with similar credit profiles and it is likely violating the fair lending requirements. We heard from many lenders who spent a good part of 2013 trying to figure out how to ensure compliance without negatively affecting their ability to purchase dealer contracts. For better or worse, the CFPB’s guidance didn’t require a magic bullet solution. If it had, lenders might have all quickly adopted changes knowing that all their competitors would do the same. Instead, a lender that changes its dealer compensation method might reduce compliance risk but then takes the risk that its new compensation method will still be attractive to dealers. A bold lender could lose business if dealers negatively react to the change. These factors may have led to some hesitation by lenders on the issue. Any hesitation probably ended in December when the CFPB
entered into a consent order with a large auto lender. In the consent order, the CFPB alleges that the lender’s discretionary dealer rate markup practices resulted in a disparate impact on certain buyers in violation of the Equal Credit Opportunity Act. The CFPB’s allegations were based on its analysis of the lender’s auto loan portfolio. The CFPB ordered the lender to institute ECOA program changes, pay $80 million to certain buyers as damages and pay the CFPB $18 million in penalties. Now there is more pressure than ever for lenders and dealers to take action to address the CFPB’s concerns. The CFPB’s March 2013 guidance offered two alternative courses of action. They aren’t perfect solutions, but they provide a clear dichotomy of choice. 1. Lender uses a discretionary dealer participation compensation method. For example, a lender might continue to allow dealers the discretion to mark up the buy rate and compensate dealers based on the amount of the markup. These methods require lenders to: u Impose controls on dealer markup and compensation policies. For example, controls could include a cap on the amount of markups. Other controls could be to allow dealers to use a set rate markup allowing variation only under certain authorized circumstances. CONTINUED ON PAGE 18
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